Author: Todd Marshall

MD: Reply to Hadrien Croubois article “About Trust and Agents Incentives”
HC: Hadrien Croubois
https://hadriencroubois.com
Oct 11, 2017PoCo Series #1 — About Trust and Agents Incentives
Who am I?
My name is Hadrien Croubois and I am a Ph.D. student at ENS de Lyon. My research as a Ph.D. student focuses on middleware design for the management of shared Cloud-based scientific-computing platforms; and more particularly how to optimise them for workflow execution.

MD: Why in the world should “cloud-based” systems even exist?

HC: However, my interests are much broader and include HPC, physics, and biology large-scale simulations, image rendering, machine learning and of course cryptography and blockchain technologies.

Since September 2017 I am also a scientific consultant for iExec. I met Gilles at ENS de Lyon and it was the perfect opportunity for me to experience working in a team designing innovative solutions.

My role as a member of this team is to study existing work from the research community and provide insight into the design of a proof-of-contribution protocol for iExec. This article is by no means a solution to this complex issue. It is rather an overview of our understanding and ideas regarding this issue.
Why iExec needs Proof-of-Contribution?

The iExec platform provides a network where application provider, workers, and users can gather and work together. Trust between these agents is to be achieved through the use of blockchain technology (Nakamoto consensus) and cryptography.

MD: COIK (Clear Only If Known). The key here is how Nakamoto establishes consensus. You really can’t know from reading the white paper that got all this started. In short, it comes down to “democracy” … i.e majority rules. In this case, over 1/2 the population. Anyone who has looked into democracy knows it cannot work with more than 50 parties involved.

HC: Our infrastructure is divided into 3 agents:

Application providers: They provide applications, which are seen as services.

MD: How do “application providers” originate?

HC: These applications can be called by the users with specific parameters. Application providers are paid for each execution of their application.

MD: Who pays the application providers. Almost the entire Android community of applications are provided at no cost whatever.

HC: The applications rely on the iExec smart contract to manage communications between the ethereum blockchain and the off-chain computing platform.

MD: COIK … what is a “smart” contract? Is it transparent? Who can see it? Who cannot?

HC: Users: They are the clients of the infrastructure. They pay to obtains results computed by the application.

MD: Seems like a non-competitive model. Take the internet itself. It is an infrastructure with no clients and no providers … or better yet, where everyone is both a client and provider. What problem is being solved here?

HC: Workers: They are computing entities that provide computing resources. These resources are used for the off-chain execution of the applications. Workers are paid based on their contribution to the computation of the applications.

MD: Again COIK. Why would workers be just “computing resources?” Seems like (reading way between the lines here) anyone being a source, or an opposition to a source, of information is a worker.

HC: The goal of the Proof-of-Contribution protocol is to achieve trust between the different agents, and more particularly between users and workers, in order for the users to be able to rely on the results computed by an external actor whose incentive is, at best, based on income.

MD: I once sat in a meeting where they made the rule that you had to say 5 nice things before you could say 1 thing critical. Want to guess how that meeting went?

HC: In particular, we want to achieve protection against Byzantine workers (who could provide bad results to penalize users) and users (who could argue against legitimate work performed by legitimate workers).

MD: Right. In sports we call those referees. But in real sports, the contestants referee themselves. We lose it when we establish rules and laws. What we really have is principles … and very few of them, the “golden principle” being paramount. Rules and laws just dilute principles. They essentially say, by defining this particular instance of the application of the principle, we declare all other applications unlawful … and thus have to define all particular instances in law after that … and thus totally lose sight of the principle. It’s called “gaming the system”.

HC: First approach: the result contribution validation scheme

Validation of the work performed by the worker can be achieved in two different ways:

Majority voting on the (hash of the) result.

MD: Like the long list of scientists who “vote” that global warming is real … when almost none of them are meteorologists or have the slightest clue of things physical?

HC: This helps mitigate against Byzantine workers but at the price of computing power overhead. Validating the result for a specific execution requires multiple workers to compute it, thus multiplying the execution cost by a factor m. In desktop grid or volunteer computing platforms (BOINC), this factor m can range from 3 all the way to 20~50. With more replication come more confidence in the result, but that also means that the reward is shared among more worker, reducing the incentive to the workers to contribute.

MD: Have you thought of a hierarchical structure to get around the fact that democracy doesn’t work with more than 50 people involved? The solution is to have each group of 50 solving the problems they can solve. They select a representative for the next lower group of 50 … and so on until you get to the final group of 50. Nothing should make it down to the bottom group of 50 and if it does, that group should come to a unanimous conclusion (establishing the principle) … not a majority conclusion. With this structure you can “democratically” represent the entire population on earth in just 6 layers of 50 person groups.

HC: Relying on a court system to solve conflicts between users and workers (TrueBit). This solution is however complicated both in terms of efforts from the users, who have to check every single result and from the platform which has to implement complex arbitration mechanisms. While this method does not require the work to be executed many times, the arbitration mechanism might call for heavy instrumentation of the execution in order for the worker to provide elements of proof if their execution is challenged.

MD: Better to make users and workers show where what they are doing “is” principled when challenged. Then let a small democratic group judge their “principled” defense … i.e. would they really want to be treated the way they are treating?

HC: A significant contribution was published by Luis Sarmenta (2002. Sabotage-tolerance mechanisms for volunteer computing systems. Future Generation Computer Systems, 18(4), 561–572). The proposed approach is based on majority voting but rather than relying on a fixed m factor, it dynamically “decides” how many contributions are necessary to achieve consensus (within a specific confidence level). The replication level is therefore dynamic and automatically adapted, during execution, by the scheduler. This helps to achieve fast consensus when possible and to solve any conflicts.

MD: Did it ever occur to you that if we had computers before we had internal combustion engines and the subsequent invention of governors that we couldn’t even mow our lawns today? The mower would become too complicated to use … and enormously unreliable … in spite of the enormous computing power that is thrown at the problem.

HC: Fig 3 from Sarmenta’s paper, describing how workers contribute to different jobs by voting on the result.

This approach relies on worker reputation to limit the potential impact of Byzantine agents and to achieve consensus.

MD: Did you read the global warming emails. You see how workers reputations are easily co-opted … how the best of systems are easily gamed by gangsters.

HC: Yet this approach is designed for desktop grid infrastructures, where money is out of the equation. Using the financial incentive of the different actors, we can modify and improve their approach to better fit our context:

Each worker retribution for computing a task can be indexed on their impact on the consensus for this task. In addition, having a good reputation helps to achieve fast consensus with fewer agents (meaning a bigger share for each agent). This gives the workers a financial incentive to act well and have their reputation go up.

MD: Do you think Digital Research would have won out over the deficient Microsoft if your rules were in place? Do you think Borland would still exist?

HC: Workers are required to commit a security deposit (stake) which is seized in case of bad behavior. This gives the worker an additional financial incentive to behave correctly.

MD: And the process for “seizure” is???

HC: The main drawback of Sarmenta’s article is the assumption that Byzantine workers are not working together and do not coordinate their attacks. While this assumption does not hold in our context, we believe we can still achieve it by selecting workers randomly among the worker pool. Therefore Byzantine workers controlled by a single entity should statistically be dispatched on many different tasks and should therefore not be able to overtake the vote for a specific task.

MD: I created a computer language (see WithGLEE.com). As I was creating it I was basking in the environment where “I” made all the decisions. I had no inertia to keep me from abandoning a bad tact, reversing it, and taking another tact. In the end I was delighted with the result. But all the time, the camel that is the collection of internet process (e.g. Java, JavaScript, Python, … etc.) won out, because though they were all deficient as horses, they had a constituency as a camel (a horse designed by committee). Python is the most obvious. You don’t use visual structure as a programming element.

While Sarmenta’s work is interesting, a few modifications are required to work in our context. In this section, we discuss preliminary ideas on how we believe this work could be adapted to iExec needs. Our idea is to orchestrate the exchanges between the users and the workers as described below.

MD: You better find a different word than “orchestrate” if you want to establish trust. Global warming is a perfect example of “orchestration”. Climate change is a perfect example of “orchestration soiling its own nest and having to change its feathers”.

HC: In addition to the users and workers, we have an additional component: the scheduler. Schedulers manage pools of worker and act as middlemen between the blockchain (listening to the iExec smart-contract) and the workers. A scheduler can, in fact, be composed of multiple programs which complementary features but we will here consider it as a single “virtual” entity.

MD: Right. Always leave openings for large numbers of regulators and bureaucrats. Did it ever occur to you that a full 3/4ths of the fruits of your labor go to government? Really bright people, when given the task of maintaining a broom in upright position, would create an enormously complicated platform using all kinds of sensors and PID controllers. Any maid would just suspend it from the top and rely on it’s naturally stable tendencies.

HC: One should notice that our discussion here does not deal with the scheduling algorithm itself. In a scheduler, the scheduling algorithm handles the logic responsible for the placement of jobs and handles execution errors. The scheduler is free to use any scheduling algorithm it desires as long as it can deal with step 3 and 5 of the following protocol.

MD: Ah yes … and to change it dynamically and often to suit conflicting whims. Ask Facebook how that’s working as they bend to demands to filter out fake news … when all they really are is a medium of communication and the content should be none of their business or responsibility. The gangsters are trying to do the same thing to the internet. Their ox is being gored badly … and what could be better than to gore their ox out of existence?

HC: Workers register themselves to a scheduler.

MD: I’m not going to comment further. This is a perfect example of the condition: “losing sight of our objective we redouble our efforts”. It’s also an example of “if I am a hammer, everything looks like a nail”. It’s also an example of “the first and best solution to every issue is government and regulation”.
Read on at your own risk!

HC: Users submit tasks to scheduler managing the work pool they chose.
Workers ask the scheduler for work to execute. The scheduler gives them tasks to be executed. Note: If we are coming from step 5 we should not ask a worker to compute a task it has already contributed to.
The worker computes the result (A) of the task. In order for this result to be validated, the platform has to achieve a consensus on this result. This is achieved through Sarmenta’s voting. In order to contribute to this consensus, the worker commits the result to the scheduler:
a. Generate and memorize (but not publish) a random value r (private disposable personal identifier).
b. Submit a transaction (contribution) with :
i. hash(A) → used to vote on an answer;
ii. hash(r) → used as a public disposable personal identifier;
iii. hash(A+r) → used as proof of knowledge of A;
iv. commitment fund (with a minimum value) → incentive to only commit good results (see later). A higher commitment fund increases the Cr (cf Sarmenta, L.F.) and thus increases the potential returns (see later);
v. A tamper-proof timestamp → Used by the worker to prove its contribution and claim its reward.
With each new vote (contribution) by the workers, the scheduler checks if an answer (hash(A)) achieves the expected likelihood threshold using Sarmenta’s voting.
a. If we do not have a consensus, the scheduler will ask more nodes to compute the same task (dynamic replication) and contribute to the consensus → go back to 3;
b. If we have a consensus continue to 6.
An answer has been selected. The scheduler can now:
a. Publish the elected hash(A). At this point no new contribution is possible.
b. Ask the winning workers for A and r. Having a value of r which matched a correct transaction dating from before the election result is a proof of contribution. At this point A can be published by any worker. The value for r shows that a worker knew the answer they voted for before the results of the election. That way they cannot claim a contribution by just submitting a transaction with the hash(A) published by other voters.
c. Check the correctness of each worker contribution.
d. Put the deposit fund (stake) of all workers who voted for another answer in the reward kitty.
e. Distribute the reward kitty (users payment + deposit fund from wrong workers) among the winning workers proportionally to their contribution (Cr value computed from the reputation and the funds committed to the vote). The scheduler may take a commission for its work.
f. Increase the reputation of winners, decrease (reset) the reputation of losers.
g. Send the, now validated, answer to the user.

Equations used by Sarmenta to compute the credibility of a result from the credibility of the voters.
Trust level, worker pools, and billing policy

Sarmenta’s voting helps to achieve the given level of confidence using worker reputation and dynamic replication. This confidence level is defined by a value ε which describes the acceptable error margin. Results should only be returned if a confidence level higher than 1-ε is achieved. This value is a balance between cost and trust. A lower ε means more confidence in the result, but also requires more reputation/contributions to achieve consensus, and therefore more work to be performed. While this value could be defined by the user for each task, they might not know how to set it and it might cause billing issues.

We believe this value should be fixed for a worker pool. Therefore the billing policy could be defined for a worker pool depending on the performance of the workers (speed) and the ε value used by this worker pool scheduler (level of confidence). The user would then be free to choose between worker pools. Some worker pools might only contain large nodes running technology like Intel SGX to achieve fast result with low replication. Other worker pools could contain (slower) desktop computers and have their consensus settings adapted to this context.

With consensus managed by the scheduler and financial opportunities for late voters provided by the security deposit of opposing voters, the users should not worry about anything. Users pay for a task to be executed on a pool of worker, regardless of the number of workers that end up involved in the consensus. If consensus is fast and easy the payment of the user is enough to retribute the few workers who took part in the vote. If the consensus is hard and requires a lot of contributions, the workers are retributed using the security deposit of losing voters. This gives the workers a financial incentive to contribute to a consensus with many voters without requiring the user to pay more.

In the current version of this work, the protocol is such as the user has no part in the consensus. Payments are done when submitting the task and no stake is required. Results are public and guaranteed by the consensus. Users can therefore not discuss a result.
Assumptions and agents incentives

We believe the protocol described previously to be secure providing a few assumptions are met :

The first strong assumption is the ability of workers to publish their transaction (contribution) in a public manner. The medium used to publish those contributions has to provide a secure way for anyone to verify that contribution have been done prior to the election results. This can simply be achieved using current blockchain technology such as ethereum smart contracts. Still, that should not prevent us from considering other approaches like DHT (distributed hash tables).
The second assumption is that the voting algorithm will, in fact, give good results. This assumption is equivalent to saying that 51% of the reputation (of a worker pool) is not controlled by a single malicious user. We believe this is not a flaw of the protocol for two reasons:
a. All voting based systems, including the Nakamoto protocol, are subject to such attacks. This flaw is not in the design of the protocol.
b. There are strong (financial) penalties for bad actions on the platform and spot checking can be enforced to give more power to the scheduler and help them deal with bad actors. It is a matter of balance between the scheduler and the workers to enable spot-checking or not. We can imagine multiple worker pools, run by different independent schedulers which specific policy. Ultimately those pools could compete to attract the users (with elements such as the achieved quality of results and pricing).

Finally, we believe that both scheduler and workers will be inclined to work correctly in order to provide a good service to the users and benefit from the iExec ecosystem. Having 51% of the reputation controlled by actors wanting to do things right and benefit from it should not be an issue.

Incentives for the different agents are as follows

Users: They are requesting work to be done, and money in a healthy system would only come from them. User incentive to use the platform is to obtain good results for a low price. This will lead them to create a competition between worker pools. Their ability to chose or boycott worker pools create an incentive for workers and schedulers to work together in order to achieve the best service possible and attract users.
Workers: Their incentive is to gain as much money as possible for their work. To maximize their gain, they should maximize their contribution. Contribution can be obtained by having a good history (reputation) and/or by committing more funds when submitting a contribution. Giving bad results would make them lose both funds and reputation, which they should avoid at all cost.
a. New actors, with no history, start with a low reputation, meaning they will weigh less in the vote. Their chance to overtake a vote against trusted workers is small, and it would be a waste of fund from an attacker.
b. An old actor with a good history can win a lot by using their reputation to perform computations. As they are trusted, fewer contributions are needed to settle a vote and the reward kitty is therefore shared among fewer agents. On the other hand, by submitting bad results they risk losing all their reputation (and the money they committed with the contribution). Reputation does not guarantee them to win votes and spot-checking can help to detect bad contributors with high reputation.
Scheduler: Their incentive is to gain money by helping coordinate the platform. They make money through:
a. Commissions on all transactions;
b. Unclaimed rewards: if a worker doesn’t claim the reward after a contribution the corresponding fund would be kept by the scheduler.

In order to make money, the scheduler requires users to submit jobs and workers to register in its worker pool. This gives him the incentive to manage the worker pool correctly and grow strong.
Public schedulers for a fully decentralized platform

One of the key elements that could ultimately help a scheduler getting bigger and attracting more workers and users is to be open about its decisions. We believe that a scheduler could rely on a blockchain mechanism to orchestrate the protocol described above. In fact, this protocol is designed so that every message can, and should, be public. Security is achieved using cryptography. In particular, the use of a blockchain solves the issue of proving a contribution existence (presence on the blockchain) and validity (precedence to the vote results).

The main issue that still has to be solved is the worker designations. At step 3, the scheduler submits the task to specific workers. This is important for two reasons:

We don’t want workers to race. This would favor fast nodes and one could attack the voting system by coordinating many fast nodes to take over the vote before other nodes can contribute.

We don’t want malicious nodes to take over some votes. By randomly assigning workers to jobs we distribute malicious nodes amongst many votes where they would not be able to take over and where their best play is to provide good results and benefit from the platform working correctly.

Such a mechanism requires a source of randomness which any observers of the blockchain can agree on. This problem is beyond the scope of this post. Having such a source of entropy could help the scheduler designate workers using a random yet verifiable algorithm. The data required for verification would be public. The only change required to the protocol would be that a valid contribution from a worker would require a proof that the worker was designated by a scheduler.

To understand the difference between a blockchain and a traditional database, it is worth considering how each of these is designed and maintained.
Distributed nodes on a blockchain.

Traditional Databases

Traditional databases use client-server network architecture.

MD: There is no such thing as a traditional database. Databases existed way before there was a client-server orientation. But we’ll assume your client-server model for purposes of this critique.

HN: Here, a user (known as a client) can modify data, which is stored on a centralized server. Control of the database remains with a designated authority, which authenticates a client’s credentials before providing access to the database.

MD: Do you think the DNS (Domain Name Service) databases fit this model?

HN: Since this authority is responsible for administration of the database, if the security of the authority is compromised, the data can be altered, or even deleted.

MD: Can we replace “authority” with “protocol” or “process” and still assume we are talking about the same thing?

HN: Traditional Databases.

Blockchain Databases

Blockchain databases consist of several decentralized nodes. Each node participates in administration: all nodes verify new additions to the blockchain, and are capable of entering new data into the database. For an addition to be made to the blockchain, the majority of nodes must reach consensus. This consensus mechanism guarantees the security of the network, making it difficult to tamper with.

MD: Don’t “shared” and “distributed” databases have this trait? If not, how can they possibly work? How about “journaled” databases?

HN: In Bitcoin, consensus is reached by mining (solving complex hashing puzzles), while Ethereum seeks to use proof of stake as its consensus mechanism. To learn more about the difference between these two consensus mechanisms, read my earlier post.

A key property of blockchain technology, which distinguishes it from traditional database technology, is public verifiability, which is enabled by integrity and transparency.

MD: Actually “public” is a relative term. Corporations have databases that do this without blockchain technology for their own “public” that can be very large and use very distributed database technologies. And airline reservations do this through federation with franchised travel agents … all without blockchain.

HN: Integrity: every user can be sure that the data they are retrieving is uncorrupted and unaltered since the moment it was recorded

MD: Only if they are believers. The only users with anything close to such an assurance are the “developers” who supposedly know “all” the complicated mechanism involved. A distributed public transparent data organization, where “anyone” can see everything gives better assurance. This is the mechanism favored by a “proper” MOE process.

HN: Transparency: every user can verify how the blockchain has been appended over time

MD: By using “trusted” API’s. There’s no way they can know the API’s they’re using should be trusted. They’re too complicated … and they’re not open.

HN: A map of Dashcoin masternodes distributed across the world.

CRUD vs Read & Write Operations

In a traditional database, a client can perform four functions on data: Create, Read, Update, and Delete (collectively known as the CRUD commands).

MD: And if the database is distributed and journaled they can do this without the “delete” and “update” … a necessary requirement for “true” transparency.

HN: The blockchain is designed to be an append only structure. A user can only add more data, in the form of additional blocks.

MD: And this causes unnecessary and undesirable latency (which is killing Bitcoin right now). Ideally, every transaction journaled into the database is “related” by hash to every other “related” transaction. What is needed is a hash linking the journal entries … and that is very easy to provide by including an input and output hash into the hashing process itself. Most transactions in a so-called blockchain block have no relevance to each other. It makes more sense to keep “related” transaction chains together rather than “all” transaction chains. This reduces latency and synchronization problems enormously.

HN: All previous data is permanently stored and cannot be altered. Therefore, the only operations associated with blockchains are:
Read Operations: these query and retrieve data from the blockchain
Write Operations: these add more data onto the blockchain

MD: Which I have described above is not “novel” at all. We have had it with journaled distributed databases for a very long time now. We have many of the mechanisms in the various forms of RAID (Random Array of Inexpensive Drives).

HN: Validating and Writing

The blockchain allows for two functions: validation of a transaction, and writing of a new transaction. A transaction is an operation that changes the state of data that lives on the blockchain. While past entries on the blockchain must always remain the same, a new entry can change the state of the data in the past entries.

MD: This is deceptive. The data in past entries never changes. The state of the current data changes by adding transactions to previous states. And you can mitigate corruption of this process with an input and output hash linking them and included in the hash of the new transactions. No block is required. Just a journal entry with two hashes … an input hash and an output hash which includes the input hash. The input hash can be verified back in time as far as the user chooses to do so … and all users my choose to do so any time they want to prove the process integrity.

HN: For example, if the blockchain has recorded that my Bitcoin wallet has 1 million BTC, that figure is permanently stored in the blockchain.

MD: A “real” money process has no such thing as a “bitcoin” wallet. It only has to prove that something claiming to be a bitcoin is not a counterfeit. A huge flaw in the bitcoin process is the fractioning of bitcoins. This is not different in end result than the fractioning of Indian (native American) lands … where they have been fractioned so many times the parcels are too small to be of use and they cannot be practically re-aggregated.

HN: When I spend 200,000 BTC, that transaction is recorded onto the blockchain, bringing my balance to 800,000 BTC.

MD: A “real” and “proper” process cares nothing about the money once it is created by traders. It only cares that it cannot be counterfeited and that the promise creating it is delivered as promised. No money is in circulation without a relation (albeit not direct) to a trader’s “in-process” promise. For any given creation, money does not exist before the promise, nor after the promise is fulfilled. In the mean time it is the most common object in every simple barter exchange … because it works. And it works because it never changes value over time an space. The “process” or “protocol” guarantees it and cannot be manipulated.

HN: However, since the blockchain can only be appended, my pre-transaction balance of 1 million BTC also remains on the blockchain permanently, for those who care to look. This is why the blockchain is often referred to as an immutable and distributed ledger.

MD: With a “real” process, the money “used” by traders is totally anonymous and unaudited. It is usually just a ledger entry in a “trusted” account … trusted by the traders using it. It may temporarily be in use as a coin or currency and returned to a ledger entry. The coin and currency are just uncounterfeitable tokens that when converted to a ledger entry are placed in storage and have no value at all. “Creation” and “destruction” and “default” and “interest” collection are a different matter (than “usage”) entirely. The traders are known and singular. They aren’t groups. They aren’t aliases. Their locations are known and they can be visited. That’s what keeps the process honest and leads other traders to “use” the money. As an example, we all “create” money when we buy a house on time. The documents recording our “promise” are recorded by the county clerk and available for all to see. We know how to do this. We also know how to streamline it (by using things like credit bureaus and title companies). As we pay back our “mortgage” we return money and it is destroyed. We don’t return the same money we created … that’s just not necessary nor can it work in practice.

HN: Centralized vs. peer to peer.

In short, the difference is Decentralized Control

Decentralized control eliminates the risks of centralized control. Anybody with sufficient access to a centralized database can destroy or corrupt the data within it. Users are therefore reliant on the security infrastructure of the database administrator.

MD: And as I have illustrated, that is not the difference, because a distributed journaled database of any kind “must” have decentralized control. What is central and known is the “process” or “protocol”.

HN: Blockchain technology uses decentralized data storage to sidestep this issue, thereby building security into its very structure.

MD: The blockchain has nothing to do with centralization or decentralization. It has everything to do with mitigating “forging” and “counterfeiting” and it does it unnecessarily inefficiently, expensively, slowly, and in an unnecessarily complicated fashion.

HN: Though blockchain technology is well-suited to record certain kinds of information, traditional databases are better suited for other kinds of information. It is crucial for every organization to understand what it wants from a database, and gauge this against the strengths and vulnerabilities of each kind of database, before selecting one.

MD: A journaled database can just manage documents or links … or links to links … or links to links to links. That is irrelevant. What is relevant is transparency of what it is managing and who is interacting with it. That’s what journaling does.

MD: You can’t get so-called crypto currencies right if you don’t know what money is. Money is obviously and provably “an in-process promise to complete a trade over time and space.” Money is always, and “only” created by traders making such promises. Money is destroyed as those traders deliver as promised. And if they fail to deliver as promised the resulting DEFAULT is immediately reclaimed by INTEREST collections from new money-creating traders with a like propensity to default.

Bitcoin suffers a big correction after swinging wildly in the last 10 days of December. … Sometime in the next three months we will see a sell-off as latecomers panic and sell. Long-term investors will remain in bitcoin and it will creep back up, but will not revisit its December highs.

Bitcoin peaked about a month ago, on December 17, at a high of nearly $20,000. As I write, the cryptocurrency is under $11,000 … a loss of about 45%. That’s more than $150 billion in lost market cap.

Cue much hand-wringing and gnashing of teeth in the crypto-commentariat. It’s neck-and-neck, but I think the “I-told-you-so” crowd has the edge over the “excuse-makers.”

Here’s the thing: Unless you just lost your shirt on bitcoin, this doesn’t matter at all. And chances are, the “experts” you may see in the press aren’t telling you why.

In fact, bitcoin’s crash is wonderful … because it means we can all just stop thinking about cryptocurrencies altogether.

The Death of Bitcoin…

In a year or so, people won’t be talking about bitcoin in the line at the grocery store or on the bus, as they are now. Here’s why.

Bitcoin is the product of justified frustration. Its designer explicitly said the cryptocurrency was a reaction to government abuse of fiat currencies like the dollar or euro. It was supposed to provide an independent, peer-to-peer payment system based on a virtual currency that couldn’t be debased, since there was a finite number of them.

MD: Delusion admission: When you’re talking about “real” money, there is a perpetual perfect balance between supply and demand for the money itself. And of course both are finite and both vary in lock step.

That dream has long since been jettisoned in favor of raw speculation. Ironically, most people care about bitcoin because it seems like an easy way to get more fiat currency! They don’t own it because they want to buy pizzas or gas with it.

MD: Common slur from those deluded about money. They call it “fiat” currency. Since all money represents a promise, and all promises are fiat, all money is fiat

Besides being a terrible way to transact electronically — it’s agonizingly slow — bitcoin’s success as a speculative play has made it useless as a currency. Why would anyone spend it if it’s appreciating so fast? Who would accept one when it’s depreciating rapidly?

MD: Bitcoin’s major flaw in this regard is its insistence on keeping track of every single trade (and thus fractioning) of the bitcoins once created. This is totally unnecessary. All you must keep track of is the creation of “real” money by traders and the destruction of it as they deliver. You must keep track of defaults and meet them immediately with like interest collections. Beyond that, the “real” money trades totally anonymously.

Bitcoin is also a major source of pollution. It takes 351 kilowatt-hours of electricity just to process one transaction — which also releases 172 kilograms of carbon dioxide into the atmosphere. That’s enough to power one U.S. household for a year. The energy consumed by all bitcoin mining to date could power almost 4 million U.S. households for a year.

MD: Tying the Bitcoin nonsense to the global warming nonsense is truly humorous. That not-withstanding, a “real” money process consumes virtually zero energy. The trees have to look elsewhere for their carbon dioxide.

MD: Governments are helpless (in a competitive sense) in defending themselves against a “real” money process. Once people see it, the nonsense of government itself is quickly exposed and governments wilt on the vine … a bloodless war ending quickly

China, South Korea, Germany, Switzerland and France have implemented, or are considering, bans or limitations on bitcoin trading. Several intergovernmental organizations have called for concerted action to rein in the obvious bubble. The U.S. Securities and Exchange Commission, which once seemed likely to approve bitcoin-based financial derivatives, now seems hesitant.

And according to Investing.com: “The European Union is implementing stricter rules to prevent money laundering and terrorism financing on virtual currency platforms. It’s also looking into limits on cryptocurrency trading.”

We may see a functional, widely accepted cryptocurrency someday, but it won’t be bitcoin.

MD: All will fail just as bitcoin will fail. Why? Because none of them behave as real money. Nothing can out-compete real money. At best, it can only tie.

…But a Boost for Cryptoassets

Good. Getting over bitcoin allows us to see where the real value of cryptoassets lies. Here’s how.

To use the New York subway system, you need tokens. You can’t use them to buy anything else … although you could sell them to someone who wanted to use the subway more than you.

In fact, if subway tokens were in limited supply, a lively market for them might spring up. They might even trade for a lot more than they originally cost. It all depends on how much people want to use the subway.

MD: Subway tokens are close to “real” money. They are created by those intending to travel. They are destroyed as they complete their trip. In the process, there is perfect balance between supply and demand for them. They fail as real money because they can only be used in one very narrow marketplace … the subway.

That, in a nutshell, is the scenario for the most promising “cryptocurrencies” other than bitcoin. They’re not money, they’re tokens — “crypto-tokens,” if you will. They aren’t used as general currency. They are only good within the platform for which they were designed.

MD: With real money, there is no distinction between tokens, coins, currency, or ledger entries. The money can move from one form to the other with perfect freedom. Just like a baton plays no role in running a race, the tokens themselves play no role in actual trading. They are simply a score keeping mechanism.

If those platforms deliver valuable services, people will want those crypto-tokens, and that will determine their price. In other words, crypto-tokens will have value to the extent that people value the things you can get for them from their associated platform.

MD: Nonsense. The proper unit of measure of real money would be the HUL (Hour of Unskilled Labor). It never changes its value over time and space. It always trades for the same size hole in the ground. So does real money.

That will make them real assets, with intrinsic value — because they can be used to obtain something that people value. That means you can reliably expect a stream of revenue or services from owning such crypto-tokens. Critically, you can measure that stream of future returns against the price of the crypto-token, just as we do when we calculate the price/earnings ratio (P/E) of a stock.

MD: Tokens and currency are real assets with “recorded” value, not intrinsic value. If I have currency and I exchange it for a ledger entry, that currency (which has never had intrinsic value but does have trading value) can be burned and there is no change in value anywhere. Money in the form of currency or tokens is only money when it is involved in trade. And if someone puts them under a mattress, it “is” involved in trade. However, if the process exchanges it for a ledger entry and the currency or token is placed on a pallet, in that store it has zero value … just like a baton sitting in a locker before or after a race plays no role in a race.

Bitcoin, by contrast, has no intrinsic value. It only has a price — the price set by supply and demand. It can’t produce future streams of revenue, and you can’t measure anything like a P/E ratio for it.

MD: This is a major major delusion. Money has a unit of measure (ideally the HUL – Hour of Unskilled Labor) but no price. This is because the supply/demand ratio is guaranteed to be perpetually unity.

One day it will be worthless because it doesn’t get you anything real.

MD: Real money will always have value as long as “responsible” traders exist. Responsible traders don’t default. They use money as it should be used … as an in-process promise to complete a trade over time and space. And the vast majority of us are responsible traders. There are really very few deadbeats and the proper money process quickly makes them uncompetitive traders and they are naturally ostracized from the marketplace.

(For more of my thoughts on the differences between cryptocurrencies and crypto-tokens, click on the video below.)

Ether and Other Cryptoassets Are the Future

The crypto-token ether sure seems like a currency. It’s traded on cryptocurrency exchanges under the code ETH. Its symbol is the Greek uppercase Xi character (Ξ). It’s mined in a similar (but less energy-intensive) process to bitcoin.

MD: Oh really? What is the distinction? What is the difference?

But ether isn’t a currency. Its designers describe it as “a fuel for operating the distributed application platform Ethereum. It is a form of payment made by the clients of the platform to the machines executing the requested operations.”

MD: With real money a process is needed to keep track of things. But that cost is negligible compared to the cost of the things being tracked.

Ether tokens get you access to one of the world’s most sophisticated distributed computational networks. It’s so promising that big companies are falling all over each other to develop practical, real-world uses for it.

Because most people who trade it don’t really understand or care about its true purpose, the price of ether has bubbled and frothed like bitcoin in recent weeks.

MD: This isn’t because of misunderstanding. It’s because there is not guaranteed perpetual balance between supply and demand for the stuff.

But eventually, ether will revert to a stable price based on the demand for the computational services it can “buy” for people. That price will represent real value that can be priced into the future. There’ll be a futures market for it, and exchange-traded funds (ETFs), because everyone will have a way to assess its underlying value over time. Just as we do with stocks.

MD: Does this suggest it somehow maintains perfect supply/demand balance for the money itself? How does it do that???

What will that value be? I have no idea. But I know it will be a lot more than bitcoin.

MD: Proving you are deluded. If you knew what money was and you knew what you speak of to be money, you know perpetually what its value will “always” be.

My advice: Get rid of your bitcoin, and buy ether at the next dip.

MD: This reminds me of the quip “you have to love standards … there are so many to choose from”.

MD: Remembering what money really is … “an in-process promise to complete a trade over time and space” … that it is only created by traders … and that for any given trading promise, it only exists for the duration of that promise … and that during that interim time, there is perpetual perfect supply/demand (i.e. zero inflation) of that money created … knowing all that, look how silly such articles like this become.

by Izabella Kaminska

In 1999, the actor Whoopi Goldberg made a bold decision. Rather than be paid for an endorsement for a dotcom start-up, she took a 10 per cent stake in the business. It seemed wise. At the time, everyone was investing in internet businesses and a rush of initial public offerings was making early investors into millionaires. I was reminded of this amid a flurry of news about the new boom in cryptocurrencies — and their celebrity backers. Ms Goldberg’s venture, Flooz, was billed as the future of money in a digital world and it hoped one day to rival the dollar.

MD: Let’s see if there is evidence that they had any clue about what money is before starting this venture. Nope!

The way it worked, however, was much less revolutionary. The service resembled a gift certificate: customers paid in dollars and received Flooz balances. These could be redeemed at participating merchants, with the hope that credits would one day circulate as money in their own right.

MD: What’s the point? How were they supposed to work without dollars kicking them off in the first place? When they replaced the dollar, what was going to create them?

The problem for Flooz was that little prevented mass replication of its model. One prominent competitor, Beenz, differed only slightly, by allowing its units to trade at fluctuating market prices.

MD: A “proper” MOE process can have no competitors. A competitor either does the exact same thing as this proper MOE process, or it isn’t competitive. And since there is no money to be made in the process (contrasted to the similar casualty insurance process where money is made on investment income), it’s not going to attract many competitors. It would be the trading commons themselves who would steward the process. We have experience with this. The internet is just such a process example … a technology commons.

Like banking syndicates before them, the ventures decided to club together for mutual benefit by accepting each other’s currencies in their networks. Even so, by 2001 both companies had failed, brought down by a lack of the one ingredient that counts most in finance: trust. Flooz was knocked by security concerns after it transpired that a Russian crime syndicate had taken advantage of its currency, while the fluctuating value of Beenz soon put users off.

MD: Fluctuating value turning users off is a good sign. Users aren’t as clueless as these entrepreneurs.

Their loss turned into PayPal’s gain, the latter succeeding precisely because it had set its aspirations much lower. Rather than replace established currencies, PayPal focused on improving the dollar’s online mobility, notably by creating a secure network that gained public support. This, it turned out, is what people really wanted.

MD: And PayPal missed the real opportunity by not following up. If they had gone ahead and implemented micro-transactions, I would be paying a tiny (what 1 cent; 5 cents?) price for reading this article. That day has to come. Supporting the likes of FT with advertising and subscriptions is just plain nonsense.

Did we learn anything from the failures of the internet boom? Apparently not. In what is looking increasingly like a new incarnation of dotcom fever, celebrities are endorsing virtual currency systems. Heiress and reality TV star Paris Hilton tweeted this week that she would be backing fundraising for LydianCoin, a digital token still at concept stage. It offers redemption against online artificial intelligence-assisted advertising campaigns.

MD: Advertising campaigns “are” artificial intelligence. We know it as propaganda. It’s annoying … and really dangerous when it reaches the minds of the stupid.

Baroness Michelle Mone, a businesswoman, announced she would be accepting bitcoin in exchange for luxury Dubai flats. What is particularly striking about this path to riches is its “growing money on trees” character.

MD: What is “particularly striking” is that someone would part with their bitcoins for one of her flats … knowing the extraordinary deflationary nature of bitcoins.

While the internet boom was dominated by IPOs, linked to a potentially profitable venture to come, this time it is “initial coin offerings” igniting investor fervour. Most ICOs do not aspire to deliver profits or returns. Indeed, from a regulatory standpoint, they cannot — most lawyers agree doing so could classify them as securities, drawing regulatory intervention which would force them into stringent listing processes.

MD: If they knew what real money was, they would know that every trader (like you and me contracting for a house or car with monthly payments) is making an ICO. What in the world is it going to take to get these brilliant idiots to recognize and understand the obvious?

That opinion was substantiated in July when the US Securities and Exchange Commission warned: “Virtual coins or tokens may be securities and subject to the federal securities laws” and that “it is relatively easy for anyone to use blockchain technology to create an ICO that looks impressive, even though it might actually be a scam.”

MD: Now isn’t that the pot calling the kettle black. The SEC is itself a scam.

So most ICOs make do by selling tokens for pre-existing virtual currencies for promises of direct redemption against online goods, services or concepts, or simply in the hope the tokens themselves will rocket in value despite offering nothing specific in return.

MD: Stupid is as stupid does. If you know that zero inflation is the right number for any money you don’t go looking for “rocketing” value. An ideal unit for money is the HUL (Hour of Unskilled Labor). We were all a HUL doing summer jobs in high-school so we can relate to them any time in our lives … and to any trade we make. The HUL itself has not changed over all time. It trades for the same size hole in the ground. With median income now at about $50,000 per year, the median person is able to trade his skilled hours for about 3.5 HULs these days.

They still think they can succeed where other parallel currency systems have failed, by bolting into pre- established blockchain-distributed currency systems such as Ethereum or bitcoin.

MD: A proper MOE process is totally transparent when it comes to the money creation/destruction parts of the process. Block-chain techniques (i.e. universally accessible ledger) would be helpful to enhance that transparency. But there would be no mining involved. New blocks would have to be created at any time at zero cost.

These already come with a network of token-owning users. But with the numbers of conventional merchants that will accept these currencies falling rather than rising, these holders need something more compelling to spend their digital wealth on. As it stands, the real economy can only be accessed by cashing out digital currency for conventional money at cryptocurrency exchanges. This comes at some expense.

MD: So far, the expense is insignificant … because of the enormous “guaranteed” continual deflation of the cryptocurrency itself (their ridiculous mining process). It’s kind of like the reverse of our government run lotteries. With government lotteries, you are guaranteed to lose (except for the minuscule chance you win). With cryptocurrency, you are guaranteed to win (until everyone loses as what is essentially a Ponzi scheme … with no Ponzi … comes down).

But with regulators clamping down on how exchanges are governed, token holders who cannot or do not want to pass through know-your-customer and anti-money laundering procedures remain frozen out.

MD: What’s disconcerting is the knowledge that if we instituted a “proper” MOE process, the regulators would clamp down on it too. It would make their current counterfeiting impossible … and it would make it impossible for money changers to demand tribute. That would just not stand. Regulators and governments everywhere are a major part of our problem.

That leaves their holdings good for only three things: virtual currency speculation, which is ultimately a zero-sum game; redemption against dark-market goods or capital control circumvention. It is assumed ICOs offering real goods, services or real estate in exchange for cryptocurrencies can somehow tap into this sizeable, albeit potentially illicit and restricted, wealth pool.

MD: Real estate wants positive inflation. Money changers in real estate do not want real money (there’s no leverage in it … time value of real money is guaranteed to be perpetually 1.0000) … and for sure they don’t want money that is guaranteed deflationary.

Yet if competing unregulated economies really start gaining traction, governments will act. China’s central bank has already branded ICOs an illegal form of crowdfunding and more rulings are expected from other jurisdictions in coming weeks.

Then again, if history teaches us anything, the system’s own propensity to cultivate fraud and unnecessary complexity in the face of more secure and regulated competition may be the more likely thing to bring it down.

MD: Actually, if you crowd the money changers existing con … “they” are likely to bring it down. “Real” money crowds money changers out of existence. That will not stand. Too bad for us traders and producers in society.

When given the choice, people usually opt for security.

MD: Which of course we don’t have … if you call government taking 3/4ths of everything we make …. you can’t call that security. I call it slavery. If you call money changers taking “all” taxes we pay as tribute … leaving governments (which the money changers instituted to protect their con) to sustain themselves by counterfeiting … I call that criminal.

izabella.kaminska@ft.com Copyright The Financial Times Limited 2017. All rights reserved. You may share using our article tools. Please don’t copy articles from FT.com and redistribute by email or post to the web.

MD: I am openly violating this request. My comments are far more valuable than anything to be learned in this article. And the fairest way to make my comments is to intersperse them in the disinformation that these articles present.

A Non-Traditional Perspective

MD: Notice that Deviant Investor represents himself as a “non-traditional perspective”. And then he rejects us in moderation for being “unorthodox”. Go figure.

Here at MD we have no illusion about what money is. We see all governments as just traders. And we see all governments for the irresponsible traders that they are … they never deliver on their money creating trading promises … they just roll them over … and that’s just plain counterfeiting.

Now let’s point out where the Deviant Investor just plain “doesn’t get it”!

Those who paid any attention to the financial press last week saw the following narrative; President Donald Trump betrayed Republicans by cutting a deal with Democrats Nancy Pelosi and Charles Schumer. They agreed to punt on the borrowing cap until December and spend $15 billion for hurricane relief.

MD: So what? The borrowing cap is an illusion. It does not exist in practicality. Every time they pretend it does, it results in a paid holiday for government workers … and them moves right on up.

Americans are supposed to conclude that Trump is flip-flopping, and that Republicans aren’t responsible. Dig just a little, and you’ll find only one of those things is true.

Trump is flip-flopping, no question about that. The president campaigned on promises to honor the borrowing limit. This tweet from 2013 is what candidate Trump had to say on the matter: “I cannot believe the Republicans are extending the debt ceiling — I am a Republican & I am embarrassed!”

MD: Man is this guy deluded! He’s recognizing Republicans (presumably in contrast to Democrats), admitting to be one, and is embarrassed by what Trump is and does? Surely he jests!

But any implication that Republican leaders in Congress actually oppose more borrowing is patently false. Republicans in Congress overwhelmingly supported the deal. It was passed in the House with a vote of 316 to 90. The Senate voted 80 to 17.

MD: Leaving me with “Trump is Flip Flopping” is the truthful statement?

Some who voted in opposition likely only did so for the sake of appearances. Others thought the president and Democrats did not go far enough. GOP leaders Paul Ryan and Mitch McConnell wanted a deal to suspend the borrowing cap for much longer than the 3 months they got.

Make no mistake – lots of Republicans share the commitment to unlimited borrowing with the President and Democrats.

MD: I agree. They should have unlimited “money creation” privileges as should all traders (within principled reason … you shouldn’t be able to create money to build a General Motors from scratch). But, as with all irresponsible traders, they should have an interest load commensurate with their propensity to default. In their case, that is 100%. Therefore, they effectively cannot create money (the borrowing metaphor is a fiction). Institute a proper MOE process in competition with theirs, and the debt ceiling no longer moves in any direction but down … until they prove themselves to be responsible traders … which of course they never will do.

At least the currency markets seem to have gotten it right. Last week’s decline in the dollar may be a recognition the debt ceiling – the final pretense of borrowing restraint – will soon be going away. The sooner investors at large arrive at this conclusion, the better it will likely be for owners of hard assets.

MD: With a proper MOE process (i.e. real money) there is no such thing as a “currency market”. The “real” money (best denominated in HULs … Hours of Unskilled Labor” never declines or increases. In a proper MOE process, money is every bit as hard as gold (but easier to trade with). Gold isn’t money at all … and never has been. It’s just a clumsy and expensive and inefficient stand-in for real money … it’s just stuff like cement blocks are stuff.

Clint Siegner is a Director at Money Metals Exchange, the national precious metals company named 2015 “Dealer of the Year” in the United States by an independent global ratings group. A graduate of Linfield College in Oregon, Siegner puts his experience in business management along with his passion for personal liberty, limited government, and honest money into the development of Money Metals’ brand and reach. This includes writing extensively on the bullion markets and their intersection with policy and world affairs.

The benefit which is derived from exchanging one commodity for another, arises, in all cases, from the commodity received, not from the commodity given. When one country exchanges, in other words, when one country traffics with another, the whole of its advantage consists in the commodities imported. It benefits by the importation, and by nothing else.

DBx: UPDATE: There is one modification to make to Mill’s statement: when producers – domestic and foreign – are better able to take advantage of economies of scale in production and distribution because of access to larger numbers of consumers, consumers – domestic and foreign – also gain in the form of greater output and lower prices of those goods and services. That is, by allowing the prices of some domestically produced goods to fall, freer trade that enables domestic producers of those goods to take advantage of the economies of scale that enables production to take place at lower per-unit costs benefits domestic consumers in a way in addition to greater access to imports.

MD: This has always perplexed me about the Mises Monks and their Austrian Economics. Why are they so fixated on prices. Prices are strictly a perception between two parties in a trade. When they have negotiated a trade to the satisfaction of both, that perception is the same for both. It has nothing to do with any other trader or trade (unless the traders themselves choose it to be).

A “proper” MOE process cares absolutely nothing about prices … ever. And by its very process, it guarantees that the money in and of itself has zero influence on prices … perpetually … and everywhere.

[I]ndividuals within the bureaucratic structure often possess wide discretionary powers to lay down rules of procedure, allocate the funds among the competing demands, or develop standards for performance.

MD: This reveals an obvious flaw in bureaucratic structures. It reveals an obvious reason why governments and their bureaucracy are not the way to address issues.

In each case, the bureaucrat who makes the decision will be motivated to some extent by his own private cost and private benefits rather than those of Congress or those which might be genuinely defined as public interest.

MD: Actually it’s much worse than stated here. Special interests now actively pursue positions in bureaucracies (being subsidized by their special interest) to further those special interests. They become an “attachment” to an existing government … and eventually take it over from within.

Bureaucrats are themselves no different from anyone else, and they will act so as to preserve and to advance their own career prospects.

MD: Actually they are very different from anyone else. They are under-skilled, competitive yet incapable of competing, and they are power hungry. It takes a special personality with a defect to be a government worker. Anyone given a choice of work in the private sector or public sector will choose the private sector … unless they are power hungry.

Hence, unless these prospects are tied directly to the public interest, the inherent inefficiency in bureaucratic process will tend to dissipate, at least to some degree, almost any collective effort to achieve social betterment.

MD: The “public interest” can never be ascertained. All that acting in the public interest does is to declare some individuals as being outside the public domain. Every action taken in one person’s interest is an action against another person’s interest.

MD: I really don’t have much to add to embrace the concept being discussed here. It is right on. Anyone who has read the Federalist Papers and particularly the Anti-Federalist papers will know the Federalists had two principle reasons for forming a union: (1) To use the union to bully the merchant’s competition. (2) To use the union to protect the merchant’s practices. It was all about what was good for the merchants … not for the people. They only thing they needed the people for was to pay for it.

Government is “never” the solution to such issues. Governments create the problem in the first place and government applied to the solution just exacerbates the problem … and leads to wars.

One of oddest tics exhibited by protectionists who otherwise have pro-free-market sympathies is to insist that the government of their country (say, the United States) use punitive tariffs and other trade restrictions in order to countervail the market-distorting effects of the policies of foreign governments. There are many problems with this specific argument for protectionism (again, not least that, in practice, it is aimed only at those policies of foreign governments that are believed to artificially lower the prices of those countries’ exports; it is never aimed at those policies of foreign governments that make the prices of those countries’ exports higher).

But here I note only that it is especially odd for people who allegedly understand and celebrate the virtues of free markets to justify protectionist restrictions on the grounds that these restrictions will allegedly countervail or “adjust for” whatever market distortions are (or are asserted to be) unleashed by the economic interventions of foreign governments. It is odd because these particular protectionists – in the U.S., many conservatives – generally distrust their government to act wisely, prudently, skillfully, knowledgeably, and apolitically when meddling in the economy. And yet as soon as the stated particular reason for intervention is foreign-government misdeeds that allegedly distort the American market, these free-market types – these free-market conservatives – lose all of their skepticism of their own governments’ abilities to intervene wisely, prudently, skillfully, knowledgeably, and apoloticially.

MD: If you start with a false pretense, you’re likely to arrive at a false conclusion. This article deals with prices and interest rates. If you know how a “proper” MOE process operates, you know there is no correlation between the two at all. Prices are determined object by object … trade by trade … trader by trader. Interest is determined trading promise by trading promise … default by default. The two are not related at all. Let’s see if Macleod gets it.

As Keynes noted, the paradox is that the price level and the nominal interest rate were positively correlated in the two centuries before he examined it in 1930.

MD: Well, duh! The prevailing MOE processes were instituted by the money changers. And they also instituted governments to protect their operations. Money changers require a “time value of money” for their farming operation (business cycle) and tribute demands (interest collections) to work. They use governments to collect this interest in the form of taxes. Governments sustain themselves through counterfeiting (inflation). Thus, with this process, price levels and interest rates will be positively correlated … over all time, not just the two centuries examined.

Monetary theory posits the correlation should be between changes in the level of price inflation and interest rates. Empirical evidence shows there is no such correlation. The response from the Neo-Keynesian and monetarist schools has been to ignore Gibson’s paradox instead of resolving it, so much so that few economics professors are aware of its existence today.

MD: There is only one kind of inflation … and thus no need for the modifier “price” in describing inflation. Inflation is simply the supply/demand imbalance in the exchange media itself. With “real” money (i.e. money in a “proper” MOE process), there is a guaranteed supply / demand balance and thus perpetual zero inflation.

This paper explains the paradox in sound theoretical terms, and casts doubt on the assumptions behind the quantity theory of money, with important implications for monetary policy.

MD: Money requires no theory … any more than addition and subtraction require theory. If you add and subtract improperly, you’re going to get an improper result.

INTRODUCTION

Thomas Tooke in 1844 is generally thought to be the first to observe that the price level and nominal interest rates were positively correlated. It was Keynes who christened it Gibson’s paradox after Alfred Gibson, a British economist who wrote about the correlation in 1923 in an article for Banker’s Magazine. Keynes called it a paradox in 1930, because there was no satisfactory explanation for it.

MD: The reason is obvious. Inflation comes from government counterfeiting (i.e. creating money with no intention of delivering on the promise that is the money they are creating). Defaults (and counterfeiting is just DOA (defaults on arrival)) must be mitigated immediately by interest collections of like amount. If they are not, inflation will result. So it is counterfeiting that causes interest collections. And if these are inadequate, it causes inflation as well. And that is the modus operandi of all (improper) MOE processes we have ever had.

He wrote that “the price level and the nominal interest rate were positively correlated over long periods of economic history”.1 Irving Fisher similarly had difficulties with it: “no problem in economics has been more hotly debated,”2 and even Milton Friedman was defeated: “The Gibson paradox remains an empirical phenomenon without a theoretical explanation”.3 Others also attempted to resolve it, from Knut Wicksel4 to Barsky & Summers.5

MD: But when you know what “real” money is … how it is created … how it is destroyed … and how defaults are immediately mitigated with interest collections of like amount … and if not, inflation results … well, there is “no” paradox at all. The behavior observed is the behavior expected. How can these so-called great economists be so clueless?

Monetary theory would suggest the correlation should have been between changes in the level of price inflation and interest rates. This is the basis upon which central banks determine monetary policy, and now that the gold standard no longer exists, it is probably assumed by those that have looked at the paradox that it is no longer relevant. This appears to be a reasonable explanation for today’s lack of interest in the subject, with many professional economists unaware of it.

MD: With a proper MOE process, there is no such thing as “monetary policy”. The proper MOE process is totally objective and immune to any attempt to influence it with policy. The gold standard never did exist. There was never enough gold for it to exist. It has always been a purposeful illusion … created by those who had the gold.

Those economists who have examined the paradox generally agree that it existed. This paper will not go over their old ground other than to make a few pertinent observations:

• Data over the period covered, other than prices for British Government Consols cannot be deemed wholly reliable for two
reasons. Firstly, price data from 1730 to 1930, the period observed, cannot be rigorous; and secondly any observations of price levels by their nature must be selective and subjective as to their composition.

MD: For price data to be useful, it must be in units that don’t change over time or space. Ounces of gold is not such a unit. A HUL (Hour of Unskilled Labor) is such a unit. It has always traded for the same size hole in the ground. So if prices (which are typically related to ounces of gold) would be translated to HULs at that point in time, the gold measurement distortion could be removed. The way to do this is to first determine the ounce of gold per HUL rate at each point in time.

• Attempts to construct a theory to explain the paradox after the Second World War differ from earlier attempts, because the more recent academic consensus dismisses Say’s Law, otherwise known as the law of the markets. Barsky & Summers in particular resort to mathematical explanations as part of their paper, thereby treating it as a problem of natural science and not a social science.

MD: “According to Say’s Law, when an individual produces a product or service, he or she gets paid for that work, and is then able to use that pay to demand other goods and services.” But what does he get paid with? He gets paid with money. And money is “an in-process promise to complete a trade over time and space”. So Say’s Law has no relevance.

• The economists who have tackled the problem were unaware of the Austrian School’s price and time-preference theories, or have dismissed them in favour of Neo-Keynesian and monetary economics. The silence of the Austrian School on the subject is an apparent anomaly.

MD: The Austrian School is totally clueless about money … what money is, always has been, and always will be. With “real” money, it is proven that its “time-value” is zero. Therefore, any “time-preference theories” are out the window. They only exist with non-zero (and particularly with positive) inflation. With “real” money, inflation is guaranteed to be perpetually zero.

The Author shows that the theoretical reasoning of the Austrian School leads to a satisfactory resolution of the paradox without having recourse to questionable statistics or mathematical method.

MD: If it does that, it does it totally by accident … or by being a paradox itself. Let’s see.

THE PARADOX

Gibson’s paradox is based on the long-run empirical evidence between 1730 and 1930, a period of 200 years, when it was observed by Arthur Gibson that changes in the level of the yield on British Government Consols 2 ½% Stock positively correlated with the wholesale price level. No satisfactory theoretical explanation for this correlation has yet been published. It is shown in Chart 1 (Note: annual price data estimates from the Office for National Statistics are only available from 1750).

MD: Where’s the mystery? The stock level is a function of inflation of the money itself. The general price of all objects is a function of inflation. They will always correlate. With a proper MOE process, that correlation curve will be a straight horizontal line.

The quantity theory of money suggests that instead there should be a strong correlation between changes in interest rates and the rate of price inflation. However there is no discernible correlation between the two. Contrast Chart 2 below with Chart 1 above.

MD: That failure to correlate is because of the failure to bring “defaults” into the analysis. If interest collections equal defaults there will be no inflation. To the extent they don’t (i.e. to the extent government counterfeiting is experienced and tolerated) there will be inflation. In a proper MOE process, interest collections are perpetually exactly equal to defaults experienced and inflation is perpetually equal to zero. They are trying to correlate the wrong two values.

If Gibson’s paradox is still relevant it presents a potential challenge to monetary policy. The question arises as to whether it is solely an empirical phenomenon of metallic, or sound money, or whether its validity persists to this day, hidden from us by the expansion of fiat currency and bank credit, and the central banks’ success in substituting pure fiat currency in place of sound money. If the paradox is solely a consequence of metallic, or sound money, it might pose no threat to the modern currency system; otherwise it may have profound implications.

MD: Monetary policy is an oxymoron when you know what real money is and the “proper” MOE process that delivers it. There is no such thing as “sound” money. This is now they refer to gold used as money. But gold represents a trade completed. It has never represented a trade in process and thus has never been money. The fact that they use it as an intermediary object does not make it money.

Modern macroeconomists appear ill-equipped to tackle this issue. The paradox is essentially a market phenomenon and macroeconomics is at odds with markets.

MD: If you’re describing issues that are a function of money and you are clueless about all things regarding money, you’re going to be “ill-equipped”.

An economist who favours macroeconomic theory will acknowledge a primary function of the state is to intervene in markets for a better outcome than a policy of laissez-faire; and that the needs and wants, the purposeful actions of ordinary people, collectively through markets free of exogenous factors, can be improved by government intervention.

MD: A person with two brain cells will recognize that the function of the state is to protect the money changers who instituted it in the first place … for that explicit purpose with the additional purpose of being the collector of the tribute they demand (i.e. taxes which are delivered to the money changers as interest payments).

Yet it is ordinary people and their businesses that were behind the relationship between the interest rate on gold or gold substitutes and wholesale prices during the period the paradox was observed.

MD: This is absolute nonsense. Ordinary people (i.e. traders) invented money. The money changers then co-opted that invention and took control in their own interests. There is no paradox here. There is only corruption. If traders institute a “proper” MOE process to compete with the money changer co-option … poof! The money changers and the governments they institute are out of business. They can’t compete. They can only tie … and they’re not interested in a draw.

For this reason an approach to the problem that is consistent with Say’s law and denies the validity of conventional neo-classical economic theory is more likely to resolve the paradox.

MD: Any economic theory is based on a false premise. When you have a proper premise no theory is called for. What is the theory of addition and subtraction?

WHY SAY’S LAW IS IMPORTANT

Say’s law describes the fundamental framework within which markets work. By implication it holds that each one of us produces a good or service so that we can buy the goods and services we want: 6 we produce to consume so we are both producers and consumers.

MD: Well duh! Is Say the inventor of “trade”. I think not!

Put another way, we cannot acquire the wide range of things we need or want without providing our labour and specialist skills for profit, the profit we require to sustain ourselves.

MD: That is not true. We trade our time, energy, skills, and/or resources for objects (produced by others time, energy, skills, and/or resources). We only profit when we use money to do this and end up with more money than we originally bargained for. If we end up with less money than we bargained for, we must add time, energy, skills, and/or resources to deliver on our original promise that created the money in the first place.

Furthermore, we may choose to defer some of this consumption for future use when it is surplus to our immediate needs. Deferred consumption is saving, the accumulation of wealth, which is either redeployed by the individual to maximise his own productive capacity, or made available to other individuals to enhance their skills for a return. The medium that facilitates all these activities is money, which effectively represents stored labour. It stands to reason that the money used has to be acceptable to all parties.

MD: It is just incredible how they can confuse and distort the obvious!

The primary purpose of money as a transaction medium is to enable all goods and services to be priced, thereby removing the inefficiencies of bartering.

MD: This is “absolutely” wrong. The “only” purpose of money is “to enable simple barter exchange over time and space.” It is created by traders making promises and getting them certified … that certificate record being money. It is destroyed by traders delivering on their promises and destroying the money (cancelling the record) they created. For any given trading promise, no money exists before the promise nor after delivery. Any trades “using” money (as contrasted with those “creating” money) view the money as the most common object in simple barter exchange.

Money enables a buyer to compare the cost and benefits of one item against another, and for producers to compete and provide what consumers most want.

MD: Not if that money allows open counterfeiting by government. In that case, the trader must estimate the inflation that that counterfeiting causes. And not if money is measured by ounces of gold. In that case, the trader must estimate the supply/demand imbalance in gold itself. An “improper” MOE process makes a trader’s job significantly more difficult … and opens the door for money changer encroachment, manipulation, and tribute demands.

The forum for this competition is the market, a term for an intangible entity, which facilitates the exchange of goods and services between producers and consumers.

MD: Correct. But money is immune to that competition if it is “real” money from a proper MOE process. This is because such a process guarantees perpetual perfect supply/demand balance for the money itself. The money itself is in perpetual free supply (created by responsible traders at will as needed to effect trading promises over time and space).

Consumers decide how they wish to allocate the fruits of their labour, and it is up to producers to anticipate and respond to these decisions. If someone is not productive and has no savings in order to consume and survive, he or she will require a subsidy, such as welfare or charity, provided from the surplus of other producers. Despite the flexibility money provides these human actions, they cannot be separated.

MD: Wrong. Someone can make a trading promise with no savings at all … and most do. Ideally, all trades would be such. Savings is an inventory control tool … it is safety stock necessary to mitigate uncertainty.

Therefore everyone is both a producer and consumer, or if unemployed, indirectly so. And it is the individual decision of the consumer what proportion of his production profit to put aside, or save for the future.

MD: Again … that is an inventory control concept.

Say’s law describes economic reality, and was generally recognised as the fundamental law of economics until about 1930. But it was an inconvenient truth for some thinkers in the late nineteenth century, most notably for Karl Marx, who advocated state ownership of the means of production, and the national socialists of the early twentieth century who advocated state control of production through regulation.

MD: Why would traders want the state involved at all when the state is obviously instituted by the money changers and is sustained totally by counterfeiting (which enables the money changers fiction of the “time value of money” … and creates the inflation that delivers that illusion … or more properly, delusion).

Both socialism and fascism were attempts by the state to subvert the free market process that allowed producers to have the freedom to respond to consumer demands, so both creeds contravened Say’s law. Finally, Keynes began in the 1930s to work up a proposition to separate production from consumption and to dismantle the relationship between current and deferred consumption, which culminated in his General Theory, published in 1936.6

MD: Keynes did nothing that wasn’t already being done. He just started twisting the money changer’s inflation knobs more drastically. More uncertainty (though it isn’t uncertain to the money changers at all … they’re driving the bus) serves the money changers farming operation … they call it the business cycle.

Keynes’s influence on modern economics is fundamental to today’s macroeconomic theories and has led to a widespread academic denial of Say’s law. Modern academics, including Keynes himself, were therefore unsympathetic with the theoretical framework required to address the paradox, if only on the basis that it was commonly accepted over the period being considered. It is also an anomaly that the subject seems to have escaped the attention of London-based economists of the Austrian School, such as Robbins and Hayek for whom Say’s law remained a fundamental basis of economic theory.

MD: What we have here is a failure to think. In this case “all” economists are provably and laughably wrong beyond belief. And the proof that they are wrong is simple beyond their wildest comprehension.

THE FINANCIAL AND ECONOMIC BACKGROUND TO 1730-1930

Gibson’s paradox was recorded in Britain, so we must first examine the social and economic conditions that pertained in order to understand the circumstances behind the paradox, and to eliminate the possibility it was the result of circumstances rather than evidence of sound theory yet to be explained.

The increase in the above-ground stock of gold, which was the foundation of money and all money substitutes for much of the time, was a potential factor over the period observed.

MD: So they’re using ounces of gold and what it trades for as their measuring stick. They’re using a rubber ruler. Is it any surprise they get spurious readings?

Uses for gold included jewellery and other adornments as well as money mostly in the form of coin, so it is not possible to establish accurately the money quantity.

MD: Which was its fallacy. Money, to be “real” needs it to be in perfectly free, unrestrained supply. Use of gold obviously constrained trade when it was confused with (i.e. used as an inefficient and ineffective substitute for) real money.

The observation was of British prices and bond yields, so it is the quantity of gold in circulation as money in Britain which matters, though there is the secondary consideration of gold in circulation in the hands of Britain’s trading partners.

MD: Make an incorrect rule and have an incorrect perception or premise, and you’re going to get an incorrect result. Gold is not money. Never has been. Never will be.

During the whole period with the exception of the 8 disruption caused by the Napoleonic wars, the quantity of gold was regulated between Britain and her trading partners solely by the demands of trade.

MD: Oh really? How about when the Spanish plundered the Aztecs? How about when new discoveries were made in California and Alaska? How about when a ship carrying a large amout of gold went to the bottom of the ocean and could not be recovered? The only way you can use gold as money is by edict … and that’s what is being explained and justified here.

Given the low level of peacetime intervention by governments in free markets at that time, differences in prices between countries were arbitraged through gold movements.

MD: It’s not a low level of “intervention”. It is a “higher” amount of counterfeiting by government in times of war. That’s why the money changers call for (and manipulate the people into) a war in the first place. The people have nothing against the people they are forced to fight.

We can therefore reasonably take the global quantity of aboveground gold stocks as indicative of the quantity of money in circulation regulated only by the market’s requirements; though bank credit or the over-issue of unbacked money became an increasing cyclical factor following the Bank Charter Act of 1844.

MD: And that is “reasonably” stupid. Stupid is as stupid does. Bank credit is a hoax brought to you by the money changers. Only traders create money … and only traders (well traders and counterfeiting governments) ever have created money.

Prior to the Napoleonic Wars, Britain began to build herself into the most powerful trading economy in history, aided by her overseas possessions and influence, together with the declining influence of Spain after the War of the Spanish Succession.

MD: Actually, it was aided by their “force”. They called it mercantilism. They just used force to limit trade to their companies. That’s why they had to have such a big and powerful navy.

The development of trade with India in the eighteenth century will have increased British demand for gold.

MD: Why? This is nonsense. It increased their demand for force. What did the Indians care about gold?

The wars against France following the French Revolution were costly both socially, involving nearly half a million men in the army and navy, and financially leading to a drain on gold reserves. Prices rose, driven by the increase in unbacked money substitutes issued by the country banks, and by the diversion of financial resources to support the war effort.

MD: Oh my! How self delusional can these writers be? When you have a false premise, you going to make false statements.

This led to the suspension of specie payments on demand against bank notes in 1797. By that time the public had become used to accepting bank notes as a valid substitute for gold, so it continued to accept them in lieu of specie.

MD: Well duh? Do you not know how the money changers farming operation works?

Following the Napoleonic wars, the economy had to adjust to peacetime. The Bullion Committee, which had been formed in 1810, recommended a resumption of specie payments to address the problem of rising prices, a recommendation rejected by the government.

MD: Right. And today we have LIBOR.

It was not until 1819, when the war had been over for four years that a second committee under the chairmanship of Robert Peel again recommended a return to specie payments, and from 1821 onwards a gradual resumption of cash payments for banknotes resumed.

MD: The money changers farming operation is maintained by jerking traders around … and front running the disruptions.

The over-issue of notes by the banks during the Napoleonic wars led to the failure of eighty country banks in 1825.

MD: And what is a bank failure? Its the bank “stiffing” the depositors. Failure is in the eyes of the beholder.

This was followed by two Acts of Parliament: in 1826 restricting the Bank of England’s monopoly to a radius sixty-five miles from London but permitting it to compete with branches in the provincial towns; and in 1833 withdrawing the Bank of England’s monopoly altogether. Banks were then free as a consequence to expand from single-office operations into branch networks through a process of expansion and mergers. The foundation of today’s British banks dates from this time.

MD: With a proper MOE process, no manipulation of any kind is possible.

During this period the debate about the future of money and banking intensified, with the banking school arguing that banks should be free to issue notes as they saw fit, so long as they were prepared to meet all demands for encashment into specie.

MD: But how were banks to put those notes into circulation as money? Answer: Traders (like you and me) put them into circulation. It has always been traders who create the money and put it into circulation. The bankers have just co-opted the process.

The currency school argued instead for bank note issues to be tied strictly to specie held in reserves. The controversy between these two schools ended with the Bank Charter Act of 1844, which required the Bank of England to back its note issue with gold, with the exception of £14,000,000 of unbacked notes already in circulation. The intention was for Bank of England notes to gradually replace those issued by other banks in England and Wales (Scottish banks still issue their own notes to this day).

MD: This is all again just manipulation by the money changers. They will accumulate gold and then dictate that it is money. When traders assimilate, they will say gold is not money and begin to counterfeit. And they will just continue the cycle.

Thus it was that the Bank Charter Act of 1844 sided with the currency school, so far as the note issue was concerned; but by neglecting the issuance of credit, modern fractional reserve banking was born.

MD: What does a charter mean when it is granted by a government to money changers … the very money changers who instituted the government to give them their monopoly and protect them from encroachment? If there was a “proper” MOE process producing “real” money, they couldn’t compete. Their monopoly would go totally unused.

It can be seen that Gibson’s paradox had to survive substantial variations of economic and monetary conditions likely to disrupt any correlation between the level of wholesale prices and interest rates.

MD: Nothing like adding irrelevant variables and noise to complicate an analysis and make prediction impossible.

If there was a common factor over the two centuries, it was that the domestic UK economy expanded rapidly, facilitated initially by a developing network of canals, which in addition to river and sea navigation enabled the transport of goods throughout the country for the first time.

MD: And such expansion would have zero impact on a “proper” MOE process. This is because money creation by responsible traders (those who don’t default) is totally unrestricted.

As the industrial revolution progressed, the new science of thermodynamics led to the development of steam power, fuelled by coal which was found and mined in abundance. The mechanisation of factories and mills together with the subsequent development of railways rapidly increased both productivity and the speed of transport and communications.

MD: And again, none of that would have been affected nor would have had an effect on “real” money. It is immune to such changes.

Her position as an important global power gave Britain access to raw materials and overseas markets to fuel economic and technological progress. Britain was so successful that before the First World War eighty per cent of all shipping afloat at that time had been built in Britain. d

MD: And that wasn’t by accident. Britain has always been a bad world citizen. They have always used force to beat down their competitors. And they have always leveraged that force by getting their competitors to fight among themselves … divide and conquer.

Finally, in the post-war decade to 1930 Britain underwent massive social and political changes, which were generally destructive to the accumulated wealth of the previous century.

MD: Wrong. They just transferred the influence to their colony … the USA. Britain never gave up colonial control of the USA.

GOLD SUPPLY

Without an increase in the quantities of gold available the expansion of economic activity brought about by the industrial revolution would have been expected to lead to a trend of falling prices.

MD: In other words, gold is “deflationary”. There is never enough of it so it becomes more dear when traders, by edict, must use it as money to effect their trading promises over time and space.

As it was, new mines were discovered, notably in California, the Klondike, South and West Africa, and Australia. By 1730 the estimated aboveground stocks accumulated through history were about 2,400 tonnes, and by 1930 they had increased to 33,000 tonnes.7 Britain’s population increased from roughly seven million to forty-five million. In other words, the quantity of gold available for money increased at roughly double the rate of the British population over the two centuries.

MD: By that data, the supply of gold would have roughly exceeded the demand for gold by double … so prices should have gone up. The price of gold should have gone down. Regardless, this just shows why you can’t use a commodity for money. It just unnecessarily complicates trades over time and space. And if the trades were being measured in units of HULs, there would be no confusion.

Other things being equal, the net monetary effect from the increase in the quantity of above-ground gold stocks can be expected to reduce its purchasing power relative to goods; but it is an historical fact that the rapid industrialisation over the period raised the standard of living and life expectancy for the average person considerably, thereby offsetting the inflationary price effects of increased above-ground stocks, so much so that prices appear to have fallen by 20% between 1820 and 1900 according to the ONS figures used in Chart 1.

MD: Again, none of that cause and effect would have bothered a “proper” MOE process at all. Injecting a commodity into the mix (and a specific commodity at that) just complicates things … unnecessarily.

THE QUANTITY THEORY OF MONEY

MD: We will know this topic to be total nonsense without even reading it. We know that with “real” money the supply is perpetually exactly equal to the demand.

The quantity theory as it is generally understood today dates back to David Ricardo, who ignored the transient effects of changes in the 11 quantity of money on prices in favour of a long-run equilibrium outcome.

MD: In electronic control systems we call this “low pass filtering”. We deal with averages and thus can ignore the noise. And it doesn’t work in electronic control systems either, if the noise and the signal appear indistinguishable.

In 1809 Ricardo took the position that the reason for the increase in prices at that time was due to the Bank of England’s over-issue of notes. His interest in this respect glossed over the short-run distortions identified by Cantillon and Hume. In the Ricardian version an increase in the quantity of money would simply result in a corresponding rise in prices.

MD: The issuance of a note is the documentation of a trader making a delivery promise that spans time and space. If note issuances increased, it meant traders increased or trading promises increased or both. If trading promises were delivered, there is no issue.

While this relationship is intuitive, it makes the mistake of dividing money from commodities and putting it into a separate category.

MD: What is that supposed to mean?

An alternative view, consistent with the theories of the Austrian School, is to regard money as a commodity whose special purpose is to act as a fungible medium of exchange, retaining value between exchanges.

MD: But it can only do that by maintaining perfect supply/demand balance of the exchange media itself… and no commodity can do that. The Austrian’s theory precludes them from using any commodity as the exchange media. And they just don’t get that!

This being the case, it must be questioned whether or not it is right to put money on one side of an equation and the price level on the other.

MD: But they’re using a “unit” of measure which is actually two units of measure combined. One unit is the “ounce”. The other unit is the “value” (i.e. supply/demand balance) of gold. That variable gold balance is the problem.

This is not to deny that a change in the quantity of money for a given quantity of goods affects prices.

MD: It should. Quantity of money doesn’t affect prices if its balance against demand for money remains constant.

That it is likely to do so is consistent with the relationship between the relative quantities of any exchangeable commodities.

MD: Supplies of exchangeable commodities are never in constant balance with the demand for those commodities … especially if those commodities are declared to be money.

Furthermore, there is an issue of preferences changing between the relative ownership of one commodity compared with another; in this case between an indexed basket of goods and money.

MD: All the more reason to reject commodities for use as money.

Changes in the general level of cash liquidity can have a disproportionate effect on prices, irrespective of changes in the quantity of money in issue at the time.

MD: With a “proper” MOE process and “real” money, cash is always perfectly liquid. Prices don’t change due to this characteristic of real money because all the money created is later destroyed by a like amount. It’s a zero sum game over time.

By ignoring these considerations it is possible to conclude that changes in the quantity of money in circulation are sufficient to control the price level.

MD: But you don’t want to “control the price level”.

It is this assumption that Gibson’s paradox challenges. To modern macroeconomists the price of money is its rate of interest, though to followers of the Austrian school, this is a gross error.

MD: It is a gross error. But Austrian school followers are in error too … in the opposite direction.

To them, the price of money is not the rate of interest, but the reciprocal of the price of a good bought or sold with it.

MD: It doesn’t get much stupider than that. With “real” money, there is no “price of money”. What’s the “price” of a HUL? It’s just a unit … an unvarying unit of measure.

Furthermore, under this logic money has several prices for each good or service, which will differ between different buyers and sellers depending on all the circumstances specific to a transaction.

MD: That’s like saying an ounce of carrots is different than an ounce of beef. It’s like saying the value of one is different than the value of the other. So what?

This is consistent with the Austrian school’s observation that prices are 12 entirely subjective and they cannot be determined by formula.

MD: Correct. But what the Austrian school fails to say is that the units used to measure those value differences must be constant over all time and space … and an ounce of gold does not come close to meeting that requirement.

Macroeconomics does not recognise this approach, and averages prices to arrive at an indexed price level. Austrian school economists argue that mathematical methods are wholly inappropriate applied to the real world. Apples cannot be averaged with gin, nor can gin be averaged even with another brand of gin. Averaging the money-values of different products cannot escape this reality.

MD: And “real” money has no interest in prices whatever. They are strictly a perception of the traders for specific trades.

The rate of interest on money is its time-preference; and again, depending on what the money is intended to be exchanged for its time-preference must match inversely that of the individual good.

MD: And this is provably wrong. Presuming the divisor is the amount of money created and the numerator is the amount of money taken to mitigate defaults ( interest collected), this has nothing to do with “time-preference” at all. If there are no defaults, a non-zero interest collection is just wrong regardless of the time span … and not allowed in a proper MOE process.

In other words, by deferring the delivery of a good and paying for it up-front it should be possible to acquire it at a discount.

MD: Why? If I supply you food, shelter, and other stuff while you build a house for me, is one of us entitled to a discount while the other is not when it comes to this trade? Of course not!

There is the possession of the money foregone, the uncertainty of the contract being fulfilled and the scarcity of the good, which all combine into a time-preference for a particular deferred transaction.

MD: Correct. But that is not the concern of the MOE process. If the MOE process detects a default, it immediately meets it with an interest collection of like amount. If it collected interest in anticipation of a larger default, it must return the difference … and vice versa. It works just like casualty insurance where PREMIUMS = CLAIMS in aggregate.

The quantity theory of money ignores this temporal element in the exchange of money for goods.

MD: And properly so with a proper MOE process where inflation of the money itself is guaranteed to be perpetually zero.

In doing so, it fails to account for the fact that in free markets demand for money, reflected in its time-preference, must correlate with demand for goods.

MD: And it does. A trader is making a trade spanning time and space. He must recover all the money he creates in delivering on that trade.

The quantity theory, by putting money on one side of an equation and goods on another suggests the relationship is otherwise. This gives us an insight into why the quantity theory of money is flawed, and when we explore the Gibsonian relationship between interest rates and the price level it will become obvious why interest rates do not correlate with the rate of price inflation.

MD: It may explain why quantity theory is flawed. Let’s see if an unflawed theory is revealed. We know the flawless process … and it’s not theoretical at all. It’s just outright obvious!

THE SOLUTION TO GIBSON’S PARADOX

In the discussion covering the flaws in the quantity theory of money in the previous section clues were given as to how the paradox might be resolved. The starting point is to recognise that money is simply a commodity, albeit with a special function, to act as the temporary store of labour between production and consumption.

MD: If you recognize money is a commodity, you are provably wrong right out of the box. Money “must” maintain perpetual perfect balance between supply and demand for the money itself … and obviously no commodity can do that. And you can make no argument for relaxing or removing this constraint. Here’s an example where the incorrect premise is revealed immediately so no further pursuit along these lines is valid. It’s not about “temporarily storing labor”. It’s about keeping score and maintain perpetual perfect balance … by detecting defaults as they occur and immediately mitigating them with equaling interest collections.

We can see that including money, commodities necessary for human progress were in demand during a period of unprecedented economic expansion over the two centuries between 1730 and 1930.

MD: There are very few commodities necessary for human progress. Water and protein … that’s pretty much it. They are not money.

In some cases, such as in exchange for harvested grains, the price of gold would have varied from season to season, often wildly.

MD: Which precludes it from being money.

But with all the individual goods, there will have been a match with their time-preferences between manufactured goods and gold and gold substitutes.

MD: Nonsense! Prove it!

Therefore, the interest rate on money offered by banks is the other side of the time-preferences of the goods produced by their borrowers, who were predominantly manufacturers and merchants seeking trade finance.

MD: Banks don’t “offer interest rates”. They “demand tribute”. With a proper MOE process, banks don’t exist at all. What in the world would they do with inflation of the money itself guaranteed to be perpetually zero.

The reason interest rates are set by the demands for money by manufacturers is they have to expend capital in order to produce. Capital becomes one of two essential elements of the price of a future good, the other essential being profit. The capital value of an asset used in production is the sum of the value of output it generates discounted to its present value.

MD: Capital is just another figment of a capitalist’s (i.e. money changer’s) imagination. A HUL delivering a hole by just scraping with flat rocks will deliver a smaller hole than one delivering a hole with the use of a shovel. But the capital cost of that shovel is huge for just a one HUL hole. And it’s minuscule for 1,000 HULs of holes.

But when you put the concept of capital in the money changers’ hands … well, it’s simply “two years”. Making a 4% spread, a money changer with a 10x leverage privilege will double his so-called capital in two years, will pull it off the table, and have no skin in the game from thereafterv … yet his so-called capital will continue to “work?” in the marketplace.

If prices of goods are rising, the producer can increase his time-preference in the expectation of higher end-prices for his production. Alternatively, if prices are not rising, or even falling he is limited in his time-preference.

MD: If prices of “all” goods are rising, you have a money problem. That doesn’t happen with “real” money.

This explains why when prices generally rose, bond yields, as proxy for term interest rates paid by borrowers, also rose.

MD: Here’s an alternate explanation. The money changers had already co-opted the traders money process. Traders seeing prices rise saw an opportunity to supply what was rising in prices. They made trading promises spanning time and space to do that … i.e. they created money. The money changers, controlling their ability to create money, charged higher and higher interest (they were opportunist). Conversely, if prices were falling, traders didn’t want to make time spanning trading promises. They hunkered down and the money changers had no opportunity. They couldn’t collect tribute for something traders didn’t want … i.e. money. But you see you get different results. when what is going on is vastly different than what “should be going on … i.e. proper MOE process”.

Equally, when prices fell, a producer was less able to bid up his time preferences, so term interest rates fell. In other words, before central banks took upon themselves to control interest rates, interest rates simply correlated to demand for capital from producers.

MD: When you artificially put yourself in the supply chain … as bankers do … you can extract tribute … if that chain is active.

This analysis of the relationship between prices is wholly in accordance with Carl Menger’s insight, that a price only exists for commodities and goods for which supply is limited to less than potential demand.8

MD: A price exists regardless of supply/demand balance for the object being traded. A price of “1.000” exists in units of HULs for all money used to effect those trades over time and space. Menger is the blind leading the blind.

POST-1930

After 1930 the paradox was still observed until the 1970s, when the relationship appeared to break down.

In the 1970s price inflation according to the ONS accelerated from 5.4% in 1969, to 17.1% in 1974.

MD: Again, there’s only one kind of inflation … supply/demand imbalance for money itself. It only arises out of an “improper” MOE process. If inflation tripled in that period, it is because counterfeiting and defaults as related to interest collections tripled in that same period.

During that time the Bank of England only increased interest rates under pressure from the markets.

MD: i.e. their interest collections were less than defaults (mostly in the form of government counterfeiting) resulting in inflation by the relation: INFLATION = DEFAULT – INTEREST in aggregate terms. Use whatever denominator suits you if you want it in terms of rates.

Interest rate policy fed a growing preference for hoarding goods and reducing personal cash balances. In this case, the correlation between bond yields and the price level reflected a shift in public confidence in the future purchasing power of the currency, which drove the time-preferences in the market, instead of widespread demand for capital investment.

MD: And there’s the fallacy. They think interest collections come out of policy. That puts them either behind or ahead of the game … and perpetually wrong.

Bond yields topped out in autumn 1974 before declining; but interest rates finally peaked in 1979/80. This is not fully reflected in the bond yield shown in Chart 4, because the yield curve was sharply negative at that time.

MD: How do you expect to analyze what’s going on when you have manipulators turning knobs like little kids turning steering wheels on a carnival car ride that’s taking them around in a circle.

Since that tumultuous decade correlation ceased, and the Bank of England appears to have gained control over interest rates from markets.

It is hardly surprising that when central banks implement monetary policies to ensure that the price level never falls, the normal relationship between the price level and interest rates is interrupted. The relationship between savers and investing producers, which is the basis of the Gibson observation, becomes impaired.

MD: Conclusion: Don’t let anyone “implement monetary policy”.

CONCLUSION

The following question was raised earlier in this paper:

If Gibson’s paradox is still relevant it presents a potential challenge to monetary policy.

MD: Monetary policy is an oxymoron and should be challenged everywhere it raises its ugly manipulatory head.

The question arises as to whether it is solely an empirical phenomenon of metallic, or sound money, or whether its validity persists to this day, hidden from us by the expansion of fiat currency and bank credit, and the central banks’ success in substituting pure fiat currency in place of sound money.

MD: If metallic money is sound money, then they have corrupted the meaning of “sound”. Metallic money can never be “real” money … and real money always easily out compete metallic money. Well, that’s not exactly true. In 1964 we had metallic coins with 90% silver. In 1965 we had metallic coins with 0% silver. In both years those coins traded for the same amount of “stuff”. Thus, the silver (intrinsic value) played no role in the trades at all.

If the Paradox is solely a consequence of metallic or sound money it might pose no threat to the modern currency system; otherwise it may have profound implications.

It is clear that the difference between markets historically and those of today is that interest rates were set by the demand for savings to invest in production, while today they are set by monetary policy.

MD: Evidence they were not determined by defaults experienced and thus they were improperly set in both instances … and achieving predictably different but improper results.

Monetary policy is not consistent with the basic function of interest rates, which is to reflect a market rate between savers and borrowers to balance supply and demand. Instead, monetarists believe otherwise, that interest rates can be used to regulate the quantity of money.

MD: Interest collections is not a policy variable. In a proper MOE process, they perpetually equal defaults experienced … just like in insurance PERMIUMS perpetually equal CLAIMS.

Gibson’s paradox is not dependent on metallic or sound money so much as it is dependent on free markets distributing savings in accordance with demand from borrowers investing in their businesses. We must therefore conclude that monetary policies intended to suppress this effect do have profound implications.

MD: A proper MOE process cares noting about savings. They have no effect on the process at all. Further, it doesn’t use the term “borrowing” or “loan” or “borrower”. It is “always” traders “creating” money which represents their in-process promise to complete a trade over time and space”… period!

Keynes in his General Theory in 1936 wrote the following in his concluding notes:

“I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work. And with the disappearance of its rentier aspect much else in it besides will suffer a sea-change. It will be, moreover, a great advantage of the order of events I am advocating, that the euthanasia of the rentier, of the functionless investor, will be nothing sudden, merely a gradual but prolonged continuance of what we have seen recently in Great Britain, and will need no revolution.”9

MD: Taking that unreadable paragraph and making some sense of it is pretty tough. But have you noticed that this article, and that paragraph, make no mention of the trader … the trader which is always the principal player … the trader without which the rentier or the functionless investor can do nothing at all?

The long, slow euthanasia of Keynes’s rentier class is what has changed. Businesses obtain the funds for investment from other sources directed by the financial system.

MD: That’s a flaw in the thinking. Investors (and funds from them) are only needed by deadbeats (those who can’t create money because they are not responsible traders) in a process of “real” money. Deadbeats are the exception … not the rule. That is, unless you are talking about governments … then they are the rule, not the exception.

Savers are channelled increasingly into stock markets, where they participate in businesses as co-owners, instead of lending to them indirectly through the banking system. The banks provide working capital, mainly through the expansion of bank credit, at rates primarily determined not by supply and demand for savings, but set by central banks.

MD: Businesses have a risk. The “individuals” running the business may create money … but they risk their responsible trader status if they fail. So they may choose to spread that risk among other traders. It’s a choice. With a “proper” MOE process, only real trading “persons” can create money. Businesses can’t do it. So when operating as a business they must resort to stocks or bonds to meet their trading needs over time and space. In so doing, they are using “existing” money created by traders with a persona.

Central banks’ insistence on monetary solutions to economic problems have not only buried the Say’s law relationship between savers and investing entrepreneurs, they have turned the principal objective of entrepreneurs from patient wealth creation through the accumulation of profits into ephemeral wealth creation through the accumulation of debt.

MD: So recognize central banks for what they are: the creation of money changers … who are the institutors of governments … who are the keepers of the central banks … who protect the money changers farming operation and demands for tribute. It’s just that simple to dissect folks! It’s a scam!

They have been caught up in a credit cycle created by central banks and are no longer borrowing genuine savings from savers who expect to be repaid. If Gibson’s paradox had been satisfactorily explained by Tooke or Gibson, the assumptions behind the quantity theory of money and its derivatives would have been thrown into doubt before they became central to monetary policy.

MD: “Credit cycle”… read “farming operation”. With “real” money, savers would do their saving by putting their money under a rock. It is always safer there than with a bank … and banks would charge them (not pay them) if they convinced the savers otherwise. They did when they held gold dust for the prospectors’ safekeeping … and were proven unsafe when they “loaned” it out and couldn’t get it back.

This is a dramatic claim perhaps, but it might have demolished the suppositions behind the quantity theory of money, which became Fisher’s equation of exchange, and the brand of monetarism followed by the Chicago school under Milton Friedman.

MD: There’s plenty of demolition to go around in this article. Both the “pot” and the “kettle” are black … and are wrong.

Misleading ideas, such as velocity of circulation in the equation of exchange would have not been taken as meaningful economic indicators. As it is Gibson’s paradox is unknown to the majority of economists today, who assume the quantity theory of money is unchallengeable.

MD: If you believe in “money supply” you have to believe in “velocity of circulation”. It is a multiplier (just like the 10x leverage bankers give themselves). But to believe in “money supply” is to have a false belief.

So, to put the explanation of Gibson’s paradox at its simplest,

If the prices of goods are expected to rise, then their time preferences are bound to increase, and if they are expected to fall, their time preferences are bound to fall. That is why interest rates correlate with the price level.

MD: If the prices of “a good” rises, then the supply/demand balance for the good has decreased … and vice versa. If time preference compacts that demand (e.g. people wanting to see the movie in its first run rather than waiting for the DVD, that’s their choice). It’s a compaction of demand though … it’s not a time preference. It doesn’t result from money having time value.

And as George W. Bush observed, this was a scholarly article … even though it is easily proven to be totally misguided and misguiding. It has footnotes.

The views and opinions expressed in this article are those of the author(s) and do not reflect those of GoldMoney, unless expressly stated. The article is for general information purposes only and does not constitute either GoldMoney or the author(s) providing you with legal, financial, tax, investment, or accounting advice. You should not act or rely on any information contained in the article without first seeking independent professional advice. Care has been taken to ensure that the information in the article is reliable; however, GoldMoney does not represent that it is accurate, complete, up-to-date and/or to be taken as an indication of future results and it should not be relied upon as such. GoldMoney will not be held responsible for any claim, loss, damage, or inconvenience caused as a result of any information or opinion contained in this article and any action taken as a result of the opinions and information contained in this article is at your own risk.

Here’s a letter to another person who caught a radio interview with me this morning:

Mr. Kasim Wagner

Mr. Wagner:

Thanks for your e-mail.

You write that “it plainly is wrong for anyone to force people to pay higher prices for supplies in disaster areas” and, therefore, “government’s duty is to protect people from this greed.”

First, I agree that it’s wrong to force people to pay higher prices. But we’re not talking about forcing people to pay higher prices. Every buyer is free not to pay higher prices. Of course, those people who don’t pay higher prices don’t get the goods. Yet people are no more forced to pay whatever prices they pay because of natural disasters than they were forced to pay whatever prices they paid before any natural disaster became a reality. All of those prices are paid voluntarily – a fact that is both economically and ethically relevant.

Second, if you truly believe that it’s unethical for anyone self-interestedly to cause consumers’ costs of acquiring much-needed goods to rise significantly, then you must believe that it’s unethical for people to rush into, and to stand in, the long lines that occur whenever there are shortages of goods. Every person standing in front of Jones in a line of consumers hoping to buy, say, bottled water self-interestedly puts his or her own welfare ahead of that of Jones. Each of those persons standing in front of Jones – both by increasing the chance that the store will run out of bottled water by the time Jones reaches the front of the line, and by increasing the amount of time that Jones waits in line – raises Jones’s cost of acquiring bottled water.

Do you believe that the individuals standing in line in front of Jones are unethical? Should government, in addition to imposing a ceiling on the monetary price that people pay for bottled water, also impose a “queue ceiling” on the number of people who stand in line to buy bottled water? If, as I suspect, your answer to each of these questions is “no,” why do you believe that government should prohibit only those increases in the costs of acquiring a good that take the form of increases in the monetary price of the good?

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

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Definition of money

Money is “an in-process promise to complete a trade over time and space”.

Proof

Examine trade: (1) Negotiation; (2) Promise to deliver; (3) Delivery.

With simple barter exchange (2) and (3) happen simultaneously, on-the-spot. Money enables (2) and (3) to happen over time and space.

Thus money is obviously “an in-process promise to complete a trade over time and space”.

The “proper” MOE process

The “proper” Medium of Exchange (MOE) process, first and foremost “guarantees” perfect balance between supply and demand for money … i.e. zero inflation of the money itself. Since this is the nature of every trade, that is easy.

The process “certifies” (i.e. documents) new trading promises .. transparently for all to see … no anonymity. That creates the money, first as a ledger entry. Later it may be exchanged for cash or currency … and back.

This money then circulates anonymously in trade as the most common object in every simple barter exchange. It loses all identity with the trader creating it. All money in the process is the same, be it record, currency, or coin.

The process then monitors in-process trading promises for performance … transparently. On delivery, the money created is returned and destroyed. On default, that orphaned money is reclaimed immediately when detected through interest collection of like amount.

To do this fairly requires actuarial techniques. The process is very similar to the operation of a Mutual Insurance Fund … but no money is to be made on investment income. There are no reserves … so there is nothing to invest.